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Investors Opposing Fee-Shifting Bylaws

May 1, 2015

As we reported in our Fall 2014 newsletter, spurred by the Delaware Supreme Court’s May 2014 ATP decision,1 dozens of U.S. public companies have recently adopted bylaws that purport to shift the company’s attorneys’ fees to an unsuccessful shareholder plaintiff in stockholder litigation. ATP held that a fee-shifting bylaw at a non-public company was “facially valid.” Public companies nonetheless have seized on ATP’s logic, and now more than 50 U.S. public companies have such bylaws.

The only clear “fix” for these bylaws would be through the Delaware legislature. Along with several other firms, KTMC has therefore encouraged several of its larger domestic clients to lobby the Delaware legislature directly.

The U.S. Chamber of Commerce argues that these bylaws simply dissuade “pirate investors” who bring “abusive shareholder lawsuit[s] and lose in court.”2 This description is false. First, the prospect of owing millions of dollars in fees would rationally dissuade

shareholders from bringing not only marginal cases, but highly meritorious ones. No matter how confident one might be in the outcome of a case, it would be foolhardy for any investor to initiate litigation if the investor’s upside is a pro rata portion of a class recovery, while the investor’s downside is potential financial ruin.

Second, the way the bylaws are written, stockholders are liable for fees even if they “win.” These bylaws generally state that the stockholder is liable for fees unless he or she “substantially achieves, in substance and amount, the full remedy sought.” A plain reading of this language would mean that a stockholder who seeks $100 million at trial but recovers (“only”) $40 million would not have “substantially achieve[d] . . . the full remedy sought” and would therefore be liable for the defendants’ fees.

As we predicted, the new bylaws being adopted by public companies are not solely limited to “fee shifting.” If directors believe, based on ATP and other decisions,3 that they are free to write the rules for stockholder litigation, then they will continue to draft more and more restrictive bylaws until such bylaws are struck down or forbidden by statute.

For example, one company included a “surety” bylaw, allowing the company to require stockholders to post a bond for the company’s litigation expenses while the litigation proceeded. Four companies passed bylaws decreeing that only stockholders owning or controlling more than 3% of the company’s stock are allowed to sue. More and more aggressive provisions are likely to be included in these anti-litigation bylaws, especially since many of the bylaws have “severability” provisions, which state that even if one provision is struck down, the remaining terms still survive.

Fee-shifting bylaws have drawn the ire of institutional investors and the proxy advisory services. Both ISS and Glass Lewis have stated that they may recommend “AGAINST” votes for directors of public companies that propose or adopt such provisions. With the assistance of KTMC and other law firms, 19 institutional investors, on behalf of funds controlling nearly $2 trillion in assets, wrote a joint letter to the Delaware General Assembly asking that such bylaws be struck down. KTMC helped coordinate a second letter, on behalf of 33 additional investors managing another $587 billion in assets, in January 2015.

The Delaware General Assembly first considered a legislative fix to ATP in June of 2014. This proposed legislation would have banned fee shifting at Delaware public corporations, on the grounds that forcing stockholders to pay a debt of the corporation would violate the fundamental “limited liability” nature of a stockholder’s investment. Deliberation on this legislation was adjourned to 2015, after significant lobbying from the U.S. Chamber of Commerce, and other corporate interests.

The Delaware General Assembly is expected to consider new proposed legislation in the first few months of 2015. We hope that legislators are moved by the institutional investors’ unanimous opposition to such provisions. Courts, not corporate directors, should be making and enforcing the rules for stockholder litigation.